1. Transfer payments

2. Social security and unemployment benefits

3. Income tax

4. VAT

Unit 8 What Should Governments Do?

Why should governments intervene in a market economy? The general argument for government intervention is market failure. Sometimes markets do not allocate resources efficiently, and government intervention may improve economic performance. Let’s discuss the six reasons why government intervention may, at least in principle, improve the allocation of resources.

The business cycle has many external causes, from wars or oil price changes to bursts of new inventions. Government policies also affect the business cycle. Increases in taxes and reductions in government spending generally reduce GNP; increases in the money stock increase GNP and prices. Government policy can make the business cycle worse, lengthening recessions and creating inflation, or it can reduce economic fluctuations. Obviously, the government cannot control the economy perfectly or we would not have severe recessions and inflation. But since the government does control a large share of total spending and the quantity of money, it must make its decisions with their effect on the business cycle in mind. And it does; taxes may be cut when the economy is in a recession, and the growth rate of money may be reduced when the inflation rate is too high or be increased when the economy is in a recession.

Most of the goods supplied by businesses and demanded by consumers are private goods

A private good is a good that, if consumed by one person, cannot be consumed by another.

Ice cream is a private good. When you eat your ice cream cone, your friend doesn’t get to consume it. Your clothes are also private goods. When you wear them, everyone else is precluded from wearing them at the same time.

But there are goods we can all consume simultaneously, without anyone’s consumption reducing anyone else’s. These are called public goods.

A public good is a good that, even if it is consumed by one person, is still available for consumption by others.

Clean air is a public good. So is national defense, or public safety. If the armed forces are protecting the country from danger, your being safe in no way prevents anyone else from being safe.

It is no coincidence that most public goods are not provided in private markets. Because of the free-rider problem, private markets have trouble ensuring that the right amount of a public good will be produced. A free-rider is someone who gets to consume a good that is costly to produce without paying for it. The free-rider problem applies particularly to public goods, because, if anyone were to buy the good, it would then be available for everyone else to consume.

For instance, suppose a market were set up for national defense. Even if each of us felt that we needed defense, we would not have the right incentives to buy our share of defense. Since the amount of national defense I will have is the same as the amount everyone else has, I have a strong incentive to wait for someone else to buy it rather than contribute my fair share. I will have a free ride on everyone else’s purchases. But of course, if everyone is waiting for someone else to buy national defense, there will be no defense.

To get around the free-rider problem, the country has to find some way of deciding together how much to spend on defense. Governments are set up to make such collective decisions. Many of the goods provided by the government are in fact public goods. National defense and police services are certainly public goods. National parks are a mixed case, since the views in the parks are a public good, at least until congestion sets in, but use of the eating facilities is not.

It may seem from this discussion that the government should produce public goods and should not produce any other goods. Neither conclusion is correct. The government does not have to produce public goods; it only has to specify how much of each should be produced. It may rely on private contractors to do the actual production, as it does, say, with regard to defense equipment. Indeed, it used to be common for countries to have private contractors provide armies on a commercial basis. It is increasingly common for municipalities to hire private contractors to remove rubbish.

On the other hand, there is no general economic reason why governments should produce private goods. There are government-owned firms or nationalized industries in most countries. Some government enterprises appear to be commercially successful and efficient. None the less, experience suggests that in many circumstances the government is less likely to produce efficiently than is the private sector.

Markets work well when the price of a good equals society’s cost of producing that good and when the value of the good to the buyer is equal to the benefit of the good to society. However, the costs and benefits of production are sometimes not fully reflected in market prices.

Consider the problem of pollution. A firm produces chemicals and discharges the waste into a lake. The discharge pollutes the local water supply, kills fish and birds, and creates an offensive smell. These adverse side-effects represent costs to society of producing chemicals, and they should accordingly be reflected in its market price — but they may not be. Unless the chemical company is charged for the damages caused by its pollution, the market price of its output will understate the true cost of production to society. In this case there is an externality in the production of the chemical.

An externality exists when the production or consumption of a good directly affects businesses or consumers not involved in buying and selling it and when those spillover effects are not fully reflected in market prices.

Externalities are not all negative. The homeowner who repaints her house provides spillover benefits for the neighbours; they no longer have to look at a peeling or dilapidated house. In all externalities, there exists something that affects firms’ costs or consumers’ welfare (such as pollution or views of newly painted houses) but is not traded in a market.

When externalities are present, market prices do not reflect all the production of a good. Government intervention may improve the functioning of the economy, for example by requiring firms to treat their waste products in certain ways before dumping them. The government might charge firms (an estimate of) the damages their pollution causes, or might permit a certain amount of total pollution and allow firms to buy and sell rights to pollute.

The presence of externalities can provide the justification for a number of government activities besides pollution control. Examples range from control of broadcasting (interference is an externality) to various restrictions on land use.

Competitive markets generally work well, but markets where either buyers or sellers can manipulate prices generally do not.

A monopolist is the single seller of a good or service.

Monopolists can earn high profits by restricting the quantity sold and raising the price. Because they are only sellers, they have no fear of being undercut by competitors — and consumers end up paying more than they should.

Some monopolies are almost unavoidable. Most public utilities (gas and electricity, for example) are potential monopolies. Other monopolies may be artificial, brought about through manipulation by firms. Here governments intervene with competition laws, seeking to make competition more vigorous and to prevent monopolies or other attempts to control supply.

In practice, modern governments engage in large-scale redistribution of income. Government spending on transfer payments represents government redistribution of income — towards the elderly (through social security), the unemployed (through unemployment benefits), farmers (through price supports), and other beneficiaries. The rapid growth of transfer spending has been a source of controversy, with critics arguing that many government welfare programmes have harmed the people they were designed to help.

Governments are concerned not just with the distribution of income, but also with the consumption of particular goods and services.

Merit goods are goods that society thinks people should consume or receive, no matter what their incomes are.

Merit goods typically include health, education, shelter, and food. Thus we — society — might think that everyone should have adequate housing and take steps to provide it. Is there an economic justification for government intervention in regard to merit goods? In a sense there always is, because the sight of someone who is homeless creates an externality, making everyone else unhappy. By providing housing or shelter for those who would otherwise be on the streets, the government make the rest of us feel better.

Society’s concern over merit goods is closely related to its concern over the distribution of income. The difference in the case of merit goods is that society wants to ensure an individual’s consumption of particular goods rather than goods in general. Some of the goods provided by the government (such as health and education) are merit goods.

The most difficult question that has to be answered in discussing both merit goods and the distribution of income is how society or the government decides who should get what. Any one person can have a perfectly sensible viewpoint on this issue — for instance, that the more even the distribution of income the better, that the distribution of income we have is best, that people who work harder should be rewarded, that people who need more should get more, or that everyone should have decent housing and no one should starve. Translating these different opinions into a consistent view that is taken by the government and implemented in taxation and transfer policy is the impossible task of politics.

Notes

1. intervene in — вмешиваться в …;

2. with their effect on business cycle in mind — помня об их влиянии на экономические циклы;

3. is in a recession — находится на спаде;

4. in no way — ни коим образом не;

5. it is no coincidence — не случайно;

6. free-rider problem — проблема “фрирайдера” — невозможность для лиц, обеспечивающих страну экономически желательным и неделимым товаром или услугой, получить за это плату с тех, кто извлекает выгоду из указанного товара или услуги, в силу того, что принцип исключения в данном случае неприменим;

7. to get around the problem — чтобы обойти проблему;

8. as it does, say, with regard to defence equipment — как оно поступает, скажем, с производством оборонной продукции;

9. it is increasingly common — все чаще и чаще;

10. in most countries — в большинстве стран;

11. appear to be commercially successful — иногда оказываются успешными;

12. experience suggests — опыт подсказывает;

13. the government is less likely to produce efficiently than in the private sector — скорее всего, правительство не сможет производить эффективнее, чем частный сектор;

14. accordingly — соответственно;

15. externality (spillover effect) — эффекты перелива, побочные эффекты;

16. seeking to make competition more vigorous — стараясь усилить конкуренцию;

17. no matter what their incomes are — вне зависимости от величины их дохода;

18. a source of controversy — источник противоречий;

19. in a sense there always is — в каком-то смысле всегда есть;

20. the more even the distribution of income the better — чем равномернее распределяется доход, тем лучше;

21. translating these different opinions into a consistent view that is taken by the government and implemented in taxation and transfer policy — если перевести все эти различные взгляды в одно твердое мнение, которого придерживается правительство, воплощая его в налоговой системе и трансфертной политике.